Cash & Liquidity ManagementInvestment & FundingEconomyConverging Factors Boost US Institutional MMFs

Converging Factors Boost US Institutional MMFs

Institutional money market fund (MMF) assets have marched steadily upward since 2004 and are now at record levels, according to Crane Data. In 2006, institutional MMFs easily broke records, closing the year with US$1.349 trillion in MMFs. The trend has remained strong in 2007. As of 31 May, Institutions held more than US$1.472 trillion in institutional MMFs.

“Institutional MMFs are hitting record levels in terms of total assets as well as their percentage of corporate and institutional ‘cash’ due to the flat yield curve, flat rate environment – and the growing complexity of the securities markets and of the world in general,” says Peter Crane of Crane Data. “Money funds, with their diversity, low costs and professional management, have proven to be the safest and most convenient way for investors both large and small to obtain competitive yields in the money markets.”

Growth in a Time of Rising Markets and Aggressive Buyback Programs

The ascendancy is all the more remarkable given two major factors that drive cash positions. The first factor is the relative strength of the US stock market. In general, a rising stock market typically means that cash positions fall as investors put more money into equities markets. Yet with major market indices moving generally upward over the past few years – and up approximately 20% in the past 12 months – MMFs have also continued to rise.

The previous high water mark for funds – when institutional MMFs topped US$1.209 trillion in 2002 – was a direct reaction to the collapse of the US equity markets following the bursting of the Internet bubble and the underperformance of many related sectors.

The sustained growth of institutional money funds also comes at a time of aggressive stock buy-back programs by scores of US companies. According to Howard Silverblatt, senior index analyst at Standard and Poor’s, S&P500 stock buyback activity continued strong during the first quarter of 2006, remaining above the US$100bn level for the sixth quarter in a row. Estimated first quarter 2007 buybacks are at US$110bn, up from the US$105bn registered during the fourth quarter of 2006. For all of 2006, buybacks are estimated to grow to US$432bn, a 23.7% gain over the US$349bn reported in 2005, and a 119% gain over the US$197bn reported in 2004, according to S&P.

“There’s a phenomenal amount of liquidity out there and with Walmart and IBM announcing significant buyback programs in recent weeks, we are likely to see this trend continue,” says Silverblatt.

A Convergence of Factors

Amid this remarkable confluence of factors, institutional money funds have steadily grown as a percentage of corporate cash. Money funds accounted for more than 27% of all corporate cash at end of 2006, up significantly from 2005, according to the Investment Company Institute’s recently released 2007 Investment Company Fact Book. All indications are – based on strong fund flows – that funds are likely to have surpassed 2002’s record 28% mark.

The accumulation of money fund assets has been well documented in surveys of corporate treasurers over the past year. Treasury Strategies released survey data in June 2006 showing that corporate cash and short-term investments in the US continued to grow in 2006, surging 7.5% to US$5.4 trillion. The Treasury Strategies poll also showed money fund holdings rose from 21% of ‘corporate liquidity’ to 27% in June 2006.

The Association for Financial Professionals (AFP) also published a survey in July 2006 that showed that organizations placed nearly 29% of cash and short-term equivalent balances into MMFs – with larger organizations more likely to use MMFs than smaller organizations.

“Money funds overall have grown at almost 20% over the past 52 weeks, or over US$400bn,” says Crane. “I expect this growth to continue, and even to accelerate, as 5% yields continue to cause investors to reconsider, and to increase, their allocation to ‘cash’.” Several factors are driving the rise of institutional MMFs:

Greater corporate efficiency: With large cash holdings, companies are looking for better ways to stash their cash. According to S&P data, interest and dividend income generated from cash reserves in the S&P500 industrials (old) grew 37.9% in 2005 and topped 40% in 2006 on the corporate earnings of the 375 issues (excluding financial, utility and transportation issues). “With so much liquidity outstanding, companies are realizing that this cash will be with them for a long time, and they are treating it like an asset – and not necessarily a short-term asset,” says S&P’s Silverblatt. “Institutional MMFs are one investment treasurers can use to maximize efficiency of their cash holdings.”

Sustained yield: April 2007 marked the first time in several years that funds yielded 5% or more for a full year. This holds both psychological and actual importance for investors, according to Crane. “Five per cent is well above money funds long-term performance (the 10-year Crane Index return through 30 April 2007 is 3.68%) and now well above the inflation rate. Investors can easily calculate a 5% return in their heads – and it quickly adds up to real dollars. Finally, a 5% return is quite competitive when compared to bonds long-term returns of around 6-7%, and stocks long-term returns of 8% or so.”

Competitive returns: Not all cash investments are created equal. MMFs can make a bottom line impact. Generally, institutional funds will track parallel to 30 or 60 day investment grade commercial paper. The advantage with MMFs is you are essentially going out on the yield curve but have a daily put option. Additionally, you have the added advantage of not directly holding single issued securities.

Safety and diversification: Because most institutional MMFs invest exclusively in investment grade, high-quality, short-term instruments that are issued by the government, corporations, municipalities, and banks, the investment is very secure. In addition, with holdings across a variety of investments, money funds spread market risk, reduce volatility and provide a stable NAV for short-term cash positions. According to Crane: “Cash is king in a more dangerous world, and MMFs provide a superior level of diversification for cash holders.”

Innovation: A Combination of Factors

While institutional MMFs have enjoyed rising success, companies continue to look for better ways to bolster the return on short-term investments. The constant drive to more efficient cash management has led banks that manage corporate relationships as well as asset managers to seek innovative solutions.

The key innovation driver is demand by corporate treasurers. The AFP liquidity survey found that the desire to have short-term assets contribute in a meaningful way to earnings growth has pushed innovation in three key areas:

Investment choice: The AFP survey found that many organizations are diversifying their short-term investments. While MMFs and bank deposits still retain the lion’s share of assets, treasurers showed greater willingness to venture into areas beyond traditional vehicles, including agency securities, euro/dollar deposits, variable rate demand notes and other instruments.

Outside management: While many organizations employ outside managers for some portion of their investments, the AFP survey found that outside experts had the potential to be especially effective to enhance performance for less liquid or lower-rated.

Efficiency: In addition to seeking better investment yields, treasurers are looking to cut costs and bring greater efficiency to the task of managing and administering a short-term investment program. Cash management portals are one key innovation that the survey cited.

Banks Take Action With Portals

With competitive pressures mounting and new opportunities rising, new innovations are being developed throughout the banking industry. From strategic partnerships to new technologies and service initiatives, banks are breaking new ground in an all-out effort to capture, serve and retain clients.

The implementation of cash management portals is one area where banks are leading rapid innovation for institutional clients. Like the mutual fund supermarkets that revolutionized the equity fund industry in the mid-1980s, the advent of MMF portals provides treasurers with a choice of competitive funds and a convenient, single-source platform for managing them. By having access to competing MMFs, corporate treasury officers can easily manage portfolios to maximize returns.

According to the AFP 2006 liquidity survey, nearly a quarter of organizations surveyed use an electronic, multi-family trading portal to execute at least a portion of their short-term investment transactions. A third of large organizations use a multi-family trading portal compared to just 15% of smaller organizations.

More recently, Crane Data, found that portals hold approximately US$230bn, or 16% of institutional MMF assets. “This is a phenomenal growth rate for a product set in this investing space,” says Crane. “Portals were virtually non-existent six years ago, and now they are poised to capture greater market share.”

Benefits of MMFs to Treasury

In research and interviews with treasurers, six key reasons are frequently cited for why corporate treasurers are integrating an MMF portal into treasury operations.

Time savings/speed of execution

Treasurers report that portals cut trading time by more than 90% and eliminate the blizzard of phone calls, faxes and paperwork that they had to process on a daily basis prior to plugging into a portal. Typically, a treasurer can log on, check money fund investments, compare yields on other funds, and select funds that meet company investment criteria – all in about five minutes.

One-stop shop

Portal technology puts research, trading and monitoring of funds under one roof. With a single platform, one log-on and access to all of the tools and information needed to manage money fund holdings, treasurers have said that they like the combination of having access to a range of quality investments with the convenience of making those investments from a single, centralized source.

Simplification/vendor consolidation

Portals that use an omnibus model for clearing and settling trades also help to streamline the fund registration process because they provide access to all funds on a portal platform with a single application. This eliminates the need to contact individual fund companies if a treasurer wants to add a new fund to his or her portfolio. Treasurers report that this function simplifies vendor relationships and allows them to put their money to work more quickly.

Cost savings

Treasury officers can reap cost benefits in three ways. By consolidating all trading activity into a single wire transfer, users of portals eliminate the daily barrage of multiple wires, thereby saving the US$10-20 charge per wire. The time savings aspect of portals also translates into administrative cost savings. By reducing the time spent on faxing, wiring and phoning associated with processing trades, corporate treasurers now have extra time to concentrate on more strategic matters and higher-value work. Finally, portal users can positively affect the lost opportunity associated with being in a low-yielding fund.

Investment transparency

Portals also provide direct and transparent access to a variety of fund information, which treasurers say helps them identify the right investments at the right time, enabling them to optimize MMF investments. The comprehensive and consolidated institutional MMF research data provided on many portals allows treasurers to isolate key industry data and streamline analysis of leading institutional MMFs at a glance.

For example, portal research tools allow treasury managers to customize data based on investment need and reliable, independent assessments from the industry’s most respected rating agencies. They can also be used to monitor assets under management and average weighted maturity of funds on watch lists; compare expense ratios of specific institutional money funds; and filter for key investment criteria.

Sarbanes-Oxley compliance

With its strict controls over financial reporting, Section 404 of Sarbanes-Oxley (SOX) raises the bar on treasury operations. Portals can help companies meet several SOX requirements for the treasury risk function. With limited access and a single password, portals provide a centralized, secure process for treasury functions. Because it is highly automated, a portal can also help maintain formal and current treasury policies, procedures and authorization matrixes and enhance process effectiveness and control. Additionally, portals can provide a clean paper trail.

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